In his recent State of the Union Address, President Obama outlined his plan to simplify the tax code and make it more fair. His approach to simplification and fairness targets tax laws he perceives as benefiting high-income taxpayers he calls “loopholes.”
One of the “loopholes” the President refers to is a “trust fund loophole.” Currently, when property passes through an estate, it receives a step-up in basis, since it is taxable to the decedent’s estate. Consider the following example: an individual leaves stock worth $50 million to an heir. When the stock was originally purchased, it cost $10 million. Upon the individual’s death, the stock is subject to the estate tax and its basis is stepped-up to $50 million. The beneficiary will not incur an income tax if he/she decides to immediately sell these shares. The $40 million increase in the value of the stock, from the time of original purchase until the death of the individual, will never be subject to capital gains tax due to the stepped-up basis. The President’s proposal would change the law or close this loophole by taxing the fair market value of capital gains, whether the stock is sold or retained.
It is important to keep in mind that President Obama’s proposal would not eliminate the current estate tax. For the tax year 2015, the estate tax exclusion amount is $5.43 million, and the top estate tax rate is 40%. Accordingly, the combined federal estate and capital gains tax could be 68%.
President Obama’s proposal protects middle-class and small businesses: for couples, no tax would be due until the death of the second spouse, and capital assets of up to $200,000 per couple ($100,000 per individual) could still be bequeathed free of tax.
The Tax Policy Center’s present statistics indicate that capital gain benefits impact taxpayers with very high incomes. The wealthy may be better able to hold on to their assets until death. In contrast, middle-class families may be forced to spend down their assets during their lifetime, which means that they had to pay tax on capital gains.
In addition, lifetime gifts of appreciated assets would be treated as taxable events. Under current law, no capital gains tax is due until the donee actually sells the gifted property (which could happen many years after the gift). The basis of the gifted property is the same as it was in the hands of the donor. Thus, if a donor, during his/her lifetime, gives a donee stock worth $14,000 that was acquired for $2,000, the donee pays the capital gains tax when the stock is sold. Under the President’s plan, this gifting of appreciated assets would trigger the taxation of the unrealized gain at the time of the gift. The proposal does not say who would be responsible for the payment of the tax, the donor or the recipient.
Finally, the President proposes to raise the top capital gains and dividend tax for higher-income earners to 28%.
The President’s proposal would bring a substantial tax increase for the wealthy. In fact, the White House projects that 99% of the impact of the President’s capital gains reform proposal would be on the top 1% of the wealthy. Most commentators suggest that the proposal is likely to be dismissed by Congress.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.